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Understanding the power of Institutions

Updated: Nov 19, 2022

Price movers in the stock market

Markets are moved by big money that comes in droves from institutions. The institutions include a barrage of entities that manage pooled money or monies of their rich owners.

 Understanding the Power of Institutions

To put this in perspective, institutions own over 80% of the equity market cap and account for 90% trading volume of all major equity indices in the US. With such high ownership and volume share, institutions are clearly the main movers of the market in either direction.

These institutions include mutual funds, hedge funds, pension funds, trusts, endowment funds, family offices, and many other set-ups that are formed to manage large pools of money from clients or members.

Vast resources and huge money power

Institutions are considered savvier and smarter than the average investor on the street because of their knowledge, expertise, and access to information. Most institutional investors employ savvy fund managers and analysts with a full-time job of finding opportunities, creating portfolios, and generating returns for clients and members.

The actions of many institutional investors are watched closely by individual investors to stay on the right side of the trade. Some investors place themselves in the trade only when they see institutional interest in the concerned asset class.

Due to their high ownership in many of the companies, the institutions also have the power to influence business and financial decisions. Some large institutions get board seats in these companies to protect their interest and ensure that the company is on the right track.

There are also institutions that take a large share in companies to influence the decision-making if they believe that those companies can do better with their interference.

Price Movers

Given their financial and research resources, institutions are big price movers in all markets. They are the price supporters at the bottom, price breakers at the top, and price movers in uptrends and downtrends.

Different institutions follow different philosophies and therefore get in and out at different times in the market. An institution like Warren Buffett’s Berkshire Hathaway would get interested in stocks in downtrends and panics, while a hedge fund like Paul Tudor’s Tudor Investment Corporation gets in when the prices are trending, as do I.

Because of the presence of numerous such institutions and trillions of dollars of assets they have, they impact prices in each phase of the markets.

As of today (15th Oct 2022) we are likely to be in or approaching the despair phase, or at least the point of returning to mean.

Many institutions will have large cash balances and will soon likely chase returns from a lower risk point. None of them will want to be behind the curve and such large inflows will at some point trigger another bull run, as it always has.....

Trend Setters

Institutions are also always on the lookout for hidden opportunities and they also are early backers of businesses, which is why they help drive the trends in business and markets.

For example, Facebook, before becoming the behemoth it is today, was a tiny start-up that got financial and logistical support from venture funds, which helped it grow and scale its business to what it is today.

Many of these companies eventually choose to issue shares to the general public to either raise growth capital or to give an exit to older investors who risked their capital to make the company successful.

Once listed on exchanges, institutions like mutual funds and index funds share ownership with other institutional investors. These institutions then become price movers in the secondary market.

Interestingly, if we look at the monthly chart for Facebook (Meta) it is incredibly similar to the phase chart above. Price has dropped an astonishing 68% from its peak 14 months ago, clearly putting it into the despair phase. Smart money and Institutions will soon be taking up positions to lead it through the stages once again. Facebook is and will not be alone, or last in this phenomena.

Many of the trends that we see today like the internet, social media, smartphones, and the hi-tech stuff like robotics and machine learning wouldn’t be possible without institutional money from the outset.

Highly Regulated

Given their clout, institutions are also highly regulated. Different countries have different regulators that form rules to protect the interests of investors, especially small investors who are not as informed as the institutions.

The regulations governing these institutions have changed quite a bit with time as the financial markets became more complex and intertwined.

For example, a number of regulations were introduced post the global financial crisis of 2008, to curb the use of complex financial derivatives that led to losses of billions of dollars for many investors.

There are also ethical codes like the prohibition of insider trading that the regulators enforce to keep these institutions from making undue profits due to their information advantage. I find this bizarre considering many are allowed to sit on the board of companies.......

Trading with the institutions

William O’Neil coined the term CANSLIM to outline his trading strategy. In this strategy, he laid special emphasis on being on the right side of institutional trades. The “I” in CANSLIM stands for the institutional check and the strategy emphasizes trading only in stocks that have at least some institutional backing.

Small traders have an advantage because of their nimbleness. Unlike institutions, which deploy large money slowly, small traders can be in and out of trades quickly. Traders can use this advantage to participate in the price spurts or declines that happen due to institutional buying and selling, respectively.

Institutions take days and weeks to acquire the desired quantity. Sometimes many institutions are chasing a small set of investable securities at the same time, leading to quick and frequent moves. A trader can benefit from such price movements if positioned appropriately.

As a trader, you need to keep an eye on securities that are under heavy institutional accumulation or distribution. This can be accomplished by using technical analysis for trading. Some charting applications also provide filters to identify securities with institutional action.

You can go through the price volume actions of many securities and shortlist the securities that show the desired characteristics of institutional activity. You then have to look for low-risk entry points to enter the trade and follow your plan to manage the trade.

Not all institutionally favourite securities will end up delivering trading profit. Therefore, you must stick to the trading discipline and cut your losses short, irrespective of how strongly you feel about an institution interested in the security you are trading.

Trading rules trump everything else in trading. So, strengthen your armor by adding the institutional check, but always be vigilant and disciplined in all aspects of trading.

My breakout strategy - 15 page rule book (PDF) is available for all members to use.

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